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Economic purpose of MUDRA loans – a sequel

The comments posted by my good friend Aashish Chandorkar prompted me to think further on this topic. The outcome of that thought process is as follows:

(1) The examples that you had cited are good and positive in the sense that the loan has not been used for consumption ends but for asset expansion. That is a good first step. The more important test is to see how these assets help them grow revenues – asset turnover, employee productivity are the key metrics.

(2) Further progress to a better size – micro to small to medium to large – is the key. There are also studies that show that incentives for small players have the perverse effect of keeping them small as they fear losing them once they grow out of those sizes. What the ASI paragraph I had cited suggests very clearly is that large factories utilise more assets, have more capital, generate more employment and add more value.

(3) In view of that paragraph I had cited in the blog, there is always the question of opportunity costs of resources. The scheme may be electorally rewarding but is this ‘personal sector’ approach a better bet for employment generation than incentivising and facilitating firms and businesses growing bigger and disincentivising them from staying small. There needs to be very open minds on this question and it is to be decided on empirical data. That is why it is important to track the systemic consequences and effects of MUDRA loans rather than just loans disbursed and the purpose for which the loans have been put to use. The outcomes are really very critical because this particular programme is almost the ‘do or die’ stuff for long-run economic prospects for the country.

(4) Lastly, international economic history over centuries is very clear and there is no ambiguity: no country has graduated to better economic status (lower middle income, middle income, etc.,) with such a big informal sector as India has.

See Table I in page 4 of the report in this link. Also, do not forget to see Table III on the labour force participation rate. India has the somewhat dubious distinction of having the third lowest labour force participation rate. Egypt and Honduras are worse than India, however.

(5) Also, parse these remarks carefully. They have an extraordinary relevance and application to India:

Countries with large informal economies tend to experience more frequent growth crises and extreme growth events. Taken together, the two parts of the chart suggest that even though growth acceleration may occur more frequently in countries with larger informal economies, the risk of sudden stops and economic crises is also significantly larger in these countries, preventing sustainable long-run economic expansion. It should be noted that this illustration does not causally link the two phenomena but suggests an empirical regularity. [Link – Chapter 5]

That is why it is important not to fall back into the habit of celebrating small and personal sectors and implicitly encourage and entrench informality in the economy. It is good to help the marginal and small farms and business units but the end-goal of such assistance should be very clear. That must be to lift them out of their small sizes.